Hi
1. I wouldn't personally interpret it as 'controlling the reserve level'. Remember, the reserving basis will be signed off and so is predetermined. A better way is to think; bonus -> reserves -> surplus
2. The insurer would carry out a bonus investigation exercise to assess the level and sustainability of the proposed bonus rate considering the surplus and other factors (e.g. PRE, past practice etc). On distributing the bonus the surplus will then reduce.
3. Another important point to make is that the proportion of surplus attributed to policyholders &/or shareholders is typically known at outset. For e.g. in a 90/10 Fund, shareholders are entitled to 1/9 of the cost of bonus or (equivalently) 10% of the distributed surplus. With-profits policyholders receive the balance.
If there are no shareholders (i.e. if we had a Mutual), then any surplus distributed would accrue entirely to with-profits policyholders.
Only the bonus attributed to with-profits policyholders will increase the reserves.
Payments made to shareholders or terminal bonus paid to maturing with-profit policies will be transferred out of the With Profits Fund and any reserves held (against the policies) will be released.
4. The answer to your last question depends.
If a net premium approach has been taken to determine the reserves then the short answer is 'yes' you're correct.
If the insurer had made allowance for future bonus in its time (t-1) valuation for future years (e.g. on Peak 2 or if a GPV is used with an explicit allowance for future bonus) then they would already have allowed for it in the time t liabilities. In this instance you still may get a change to the liabilities (all else equal) if the assumed bonus rate made for the year to time t was different to the rate actually declared.
I am conscious that this is getting complicated and is well beyond what is required for ST2 but I hope this is useful in answering your question.
Last edited: Mar 28, 2014